Term Structures of Credit Spreads with Incomplete Accounting Information

Abstract

Abstract:We study the implications of imperfect information for term structures of credit spreads on corporate bonds. We suppose that bond investors cannot observe the issuer's assets directly, and receive instead only periodic and imperfect accounting reports. For a setting in which the assets of the firm are a geometric Brownian motion until informed equityholders optimally liquidate, we derive the conditional distribution of the assets, given accounting data and survivorship. Contrary to the perfect-information case, there exists a default-arrival intensity process. That intensity is calculated in terms of the conditional distribution of assets. Credit yield spreads are characterized in terms of accounting information. Generalizations are provided. 1 We are exceptionally grateful to Michael Harrison for his significant contributions to this paper, which are noted within. We are also grateful for insightful research assistance from Nicolae Gârleanu, Mark Garmaise, and Jun Liu; for very helpful discussions with Martin Jacobsen, Marliese Uhrig-Homburg, Marc Yor, and Josef Zechner; and for comments from Michael Roberts, Klaus Toft, William Perraudin, Monique Jeanblanc, Jean Jacod, Philip Protter, Alain Sznitmann, Emmanuel Gobet, Anthony Neuberger, Jason Wei, Pierre de la Noue, Olivier Scaillet, numerous seminar participants, as well as Drew Fudenberg and several anonymous referees. Duffie is at GSB Stanford CA 94305-5015 (Phone:

Informational Asymmetry Between Managers and Investors in the Optimal Capital Structure Decision

“…One notable contribution in this direction was recently made by Duffie & Lando (2001), who essentially extend the model by Leland & Toft (1996) to incorporate incomplete information on the part of investors. Being mainly concerned with the implication on credit spreads, they show that credit spreads in structural models can become non-negative for very short maturities, which remedies an important critique on structural credit risk models.…”

“…Being mainly concerned with the implication on credit spreads, they show that credit spreads in structural models can become non-negative for very short maturities, which remedies an important critique on structural credit risk models. Giesecke (2003) builds upon Duffie & Lando (2001) to extend their analysis to consider not only incomplete information about the asset value but also imperfect information about the default barrier. 7…”

“…They argue that in the Duffie & Lando (2001) model the market receives a noisy version of the asset value, i.e. the asset value plus a noise component added.…”

“…The first class is based upon agency costs, while the second focuses on informational asymmetries. 50 In this section, we will contribute to the second class in that we broadly follow the approach taken by Duffie & Lando (2001) who assume that the incomplete information on the part of investors is given by the fact that they only receive noisy signals about the relevant state variable. In forming rational estimates investors are faced with the problem of filtering away this noise.…”

Optimal contracting with effort and misvaluation

“…Our setting also accounts for the fact that manager and shareholders do not observe the outcome process directly. Following evidence that accounting reports are typically contaminated by accounting noise (see also the models of Duffie and Lando (2001) and Capponi and Cvitanić (2009)), we assume that the manager and the shareholders can only observe a white noise contaminated version of the actual output. Moreover, while managerial effort cannot be directly contracted upon by the principal, she can either observe it or compute it correctly in equilibrium.…”